Rants and musings about things political, philosophical, and religious.

Wall Street Drunk and Drinking More

Former President George Bush was wrong on many issues, but at least one of his comments was right on the money. At a private fundraiser in Houston in July 2008, during one of those many unscripted moments, Bush opined on some of the reasons behind the then-nascent economic decline. His simple summary was that “Wall Street got drunk”.

While metaphorically true in a sense, what he failed to mention was that the government was primarily responsible for supplying the cheap booze to the bankers. Wall Street did indeed get drunk on credit default swaps, mortgage-backed securities, and easy money through artificially-controlled low interest rates. None of this would have been possible, however, without the Federal Reserve’s control over America’s paper-based monetary system and the existence of a fractional-reserve banking system which creates credit out of little more than thin air. Frat boys can’t get drunk without access to cheap (or free) beer, and bankers can’t compound investments and risky loans without a “lender of last resort” who is willing to finance the shenanigans.

Centralized economic planning may work well in the short term for a select few, but nobody is smart enough to manage the economic interactions of hundreds of millions of people over many years. Today’s dollar being worth only 4% of the 1913 dollar, when the Fed took it over, is just one evidence of this truth. A wise parent would not give their alcohol-guzzling teenager the keys to the new family car, and yet America’s financial fate has largely been entrusted to similarly reckless individuals.

Now that the bubble has begun to burst, the sane segment of the American population believes that the winos in Wall Street need to sober up. Last I checked, however, nowhere in Alcoholic Anonymous’ 12-step program will you find the counsel to keep drinking while on your path to recovery. And yet, oddly enough, this is precisely what the federal government is trying to do to allegedly fix the economy. Bailouts, stimuli, subsidies, and increased spending are all attempts to allegedly sober up Wall Street… by sending them a few kegs of beer. How is this solving anything?

Just as one cannot sober up through increased alcohol consumption, so it is with the federal government’s economic health. We cannot pull ourselves out of debt by borrowing or printing more money. It doesn’t work for individuals, and it doesn’t work for governments. America needs its own 12-step program for financial wellness, and leadership with the integrity and tenacity to see it through.

While a gradual process of overcoming an addiction is often beneficial, sometimes going cold turkey is the best option available. To be sure, the immediate termination of the many spending programs being implemented under the umbrella of the stimulus, bailouts, and federal budget appropriations would be political suicide. The masses are clamoring for bailouts and stimuli of their own, and are not likely to look favorably upon somebody telling them no.

But the best thing for a drunkard’s well being is the companionship of a firm and loving person who will tell them no, even when it’s tempting and easy to choose otherwise. Wall Street got drunk, and the government has been the enabler. Supplying more money, loose credit, and low interest is the worst thing that we can be doing. It’s time to take away Wall Street’s car keys: no Federal Reserve, no fractional-reserve banking, and no federal stimuli or bailouts.

8 Responses to “Wall Street Drunk and Drinking More”

…….and the existence of a fractional-reserve banking system which creates credit out of little more than thin air.

I sense there is an underlying assumption here, that some forms of currency somehow have inherent, independent, implacable value, while others do not. Note that the value of any and all currencies depends entirely on faith and supply. It doesn’t matter the form or where the currency comes from. Gold, for example, is not different. If you use the gold standard, it’s not governments, but mining companies which create money “out of thin air,” or “out of the ground” in this case. They can be expected to do this as much as they possibly can.

I don’t see the problem with creating credit “out of thin air” so to speak. This is a net zero-sum process, in the sense that the money that is supposedly printed ex-nihilo, vanishes upon repayment of the loan. There is a reasonable expectation of repayment. Banks aren’t allowed to claim more revenue than they have actually collected; that would be fraud. If you can’t understand how modern banks can lend more than they actually hold in capital; and why this helps both banks and their debtors to be more productive……creating credit is not the same as printing money.

Even if banks didn’t do this, there are plenty of other ways they could incur risk. I think it’s inconsistent to single out one type of financial risk and minimize others.

Money and value can just as easily disappear into the void, e.g. a drop in the value of a stock or real property. Money disappears this way, as if one had placed a dollar in a piggy bank, and when you tried to take it back out only 60 cents were there.

Today’s dollar being worth only 4% of the 1913 dollar, when the Fed took it over, is just one evidence of this truth.

So, you’re suggesting we should return it to the value it had back then? Deflation hurts just about everybody.

But wait just a minute here, this claim can easily be reversed. Before the institution of our current fractional reserve system, the value of the dollar fluctuated wildly, unpredictably. there was no pattern to it. The dollar experienced periods of rapid inflation, followed by crushing deflation. After the Fed, it’s value declined at a constant, predictable, but fairly slow rate. Predictable decline is far better than no predictability. The logic behind this, is that constant low level inflation is preferable over deflation, unpredictable inflation, or even currency stagnation. Stagnation hurts, because people don’t want to invest in real estate, for example.

The federal reserve in unequivocally at fault for enabling the drunkenness. They were more like pushers, than enablers, though. What caused the bubble and crash were bad governmental policies (meant to stimulate the economy and get more people into houses) coupled with low interest rates (which the Fed controls). And inflation has skyrocketed since the creation of the Federal Reserve because they have the power to create money out of nothing. It’s simple supply and demand- supply goes up, value goes down. Here is a chart showing inflation since 1800. Notice the sharp incline after 1913, when the Federal Reserve was created: http://webpages.charter.net/prologue/images/Before_And_After_The_Fed.gif

Connor: I like your analogy! I would add, though, that the government is giving Wall Street more alcohol to prevent one humongous hangover. Sadly, if you keep feeding a drunk alcohol, sooner or later their liver fails. Wall Street can’t keep this up forever.

Josh Williams: Actually, with today’s credit interest rates, debt takes a long time to be repaid. Many loans, then, and the attending increase in the money supply, have relatively long lasting effects on the economy.

I would also like to challenge your assertion that the fed has kept inflation “low level” and “constant” with this graph.

Inflation took off in the late 70’s after the breakdown of the Bretton Woods system. Here is a chart that further illustrates my point. From the beginning of the dollar through 1913 the CPI was relatively stable, between .03 and .07 (as compared to the 2008 dollar). There were panics, but can they be attributed to an inherent instability of functioning without a federal reserve?

This chart shows that there were identical panics in France and England almost every time we had one. (England did have a central bank, throughout it all.) Obviously, something else was in the works at the time. The author of the book assumed it was over-speculation, and the herd mentality of people, which causes things to snowball. In any event, the book points out that in our history there have been panics every 9 or 10 years, like clockwork, whether we had a national bank or not. Our worst financial panic ever occurred under the auspices of the Fed. in 1929. We have continued to have recessions since then, quite regularly. The only reason they don’t turn into full fledged panics is because there are laws in place to shut down banks before they are stripped clean of funds and to insure depositors funds when this happens. (Which is mostly psychological, as we have seen as the FDIC has declared itself in the red recently.)

An amusing, but no less valid indicator of inflation would be the “Hershey Bar Index” from The Food Timeline website.

In 1970 a Hershey’s bar was just 10 cents. By 1977 it had doubled to 20 cents.

Right now our dollar is in a tug of war with the stock market. If we let the dollar appreciate, we lose points on the Dow, if the Dow rises, the price of the dollar falls. Some have speculated this is because the only way we are to get a rise in the stock market at this point, is losing dollar value, so in essence, the rises in stock prices are not due to increased value of stocks, but the need to have more dollars to equal the same value.

When I look at recent trends in the US economy, I see these points of interest: First, the devaluation of our dollar, and the resultant increase in prices have outpaced the rise in incomes. Americans are therefore forced to either lower their standard of living, work more, or borrow more. It appears that at first, sending the wife to work was the answer, but even that couldn’t keep pace with inflated prices, so they turned to credit to fill the gap. The Federal Reserve was happy to support this trend with lower interest rates making borrowing and spending even more desirable than scrimping and saving.

Second, the amount of money required to support families in the US has become so outrageous that companies are now moving on to the third world where wages are more in line with the prices people worldwide are willing to pay for the goods being produced. This is not just related to price increases, however, it is also related to US worker’s expectations of what kind of lifestyle they are to live. In any event, I think the relationship between prices and the cost of doing business in the US has broken down so that it is impossible for manufacturers to cover expenses (including taxes) keep prices affordable for Americans, and still make a profit that will satisfy the shareholders.

The economy is like a very delicately balanced machine. In order for it to work smoothly, all parts must be functioning in their proper order. It doesn’t take much for something to get out of whack and then throw the whole thing off. That is why it is important to save money in good times, instead of spending it and blowing up the bubbles further, and using the savings in hard times to meet shortfalls. The idea that we can borrow and spend ourselves into prosperity has been shown to be a disaster. The Federal Reserve can not get around this truth. As US citizens, neither can we.

Many loans, then, and the attending increase in the money supply, have relatively long lasting effects

I’d love to read more about the argument that “leveraging” credit like that affects the money supply and thus inflation. You may be correct; I’m not sure what the exact term for lending money ex nihilo like that is. A counter argument might be that it also affects productivity and the supply and trade of goods. As I hope you’re familiar, work or productivity in the economy is not driven by the supply of money, but by it’s rate of exchange, or “liquidity.” This is why taking your savings out of banks and stuffing it in your mattress is harmful to the economy.

I’m not sure how familiar you are with the calculus or math in general. The graph showing consumer prices does have some surprising trends. But let me explain that gross consumer prices should be “inversely proportional” to the value of the dollar. In other words, if the value of the dollar decays exponentially, the prices of goods should grow exponentially, in a way that’s roughly proportional. So according to the graph CPI roughly fits the pattern you’d expect.

However, since the 80’s the CPI looks to be merely growing in a more linear way, not exponentially, which might possibly suggest that the real-world value of consumer goods has actually gone down, not accounting for changes in the inflation rate. If you adjust for inflation, dividing by the relative value of the dollar(the so-called “real” CPI), the value of goods and services has only gone up slightly, on the whole.

The price of the Hershey bar more closely seems
to match the expected pattern of exponential growth/exponential decay, than does the graph of the CPI. Then again, prices of individual goods are subject to plenty of other factors.

It’s a little more meaningful to compare consumer prices to median salaries, as you have done. (Median, meaning the most common salary. The simple average tends to get distorted by the super-rich few at the top.)

I totally agree with you that the last three or four decades have seen a huge problem with wage stagnation in the US, which has been out of pace with (official) figures for the US GDP. This is an extremely complicated issue in itself, many books have been written on the subject. It’s also worrisome that long-term savings have dropped to abysmal levels. I think it’s fair to say that everyone’s spending money a lot faster, instead of saving it. This can be a boost to the economy since it improves “liquidity” and productivity, but it also comes at a terrible risk.

Note that out-sourcing jobs only makes sense for large-scale manufacturing, and to a lesser extent, intellectual-labor type jobs. Services, small-scale manufacturing, and of course management are not going anywhere.

I am concerned with the fact that China and India both graduate far more scientific and engineering degrees than the US, while the have have a much greater proportion of business and law degrees. There’s some evidence that we’re losing our technological edge which is what made us a superpower. Maybe that’s not necessarily a bad thing.

The economy is like a very delicately balanced machine. In order for it to work smoothly, all parts must be functioning in their proper order.

I feel that this is a notion which is patently false. There is no evidence to suggest this. Quite the contrary. The economy is not a system which naturally seeks “balance”, or equilibrium.

This may seem like I’m splitting hairs, but I think this is a particularly troublesome presumption to make, when it’s used to justify political dogma.

The idea that the economy is like a “balanced machine” directly implies that it can be easily and accurately predicted; which you should know isn’t the case in economics. To extend the metaphor, even if a machine has “broken parts” it will still malfunction in predictable ways. Determinism and predictability are only found in some systems. Others, even if their laws and starting conditions can be perfectly known, they still behave chaotically! A perfect example of this is quantum mechanics.

This notion also has a logical requirement that the “rules of the game” can’t change, and furthermore that there is not a flow of new knowledge to the actors in the system which amount to changes in the rules. These are also not true. If you’re a fan of board games, you can easily observe that small changes in the rules can have huge effects on the outcome.

In other words, what I’m saying is it’s not a case of something being “out of whack” which once fixed, “order” will be restored.

Chaos IS the inevitable state of the system, order and predictability cannot be imposed on it anymore than you can engineer the weather,….. unless you want to turn humans into perfect automatons. The economy is basically founded on human behavior which is not machine-like; it is not logical or predictable.

A friend of mine pointed out to me that even if the economy WAS an equilibrium process, nothing says that it the result would be an equilibrium state which met the needs and interests of most people. In fact it’s likely that such an equilibrium condition wouldn’t be one which was favorable to the majority. The former would require a very exclusive set of circumstances indeed; while NOT meeting people’s needs could occur over a wide range of economic circumstances.

Part of this premature notion of “equilibrium” comes from the work of the mathematician John Nash…but that’s a whole different tangent.

Here are some things I found in response: First, I found a very simplistic explanation of money and the role of credit in its creation on the Dallas Fed site, that nevertheless explains the effect of loans on the money supply clearly.

How Banks Create Money
Banks actually create money when they lend it. Here’s how it works: Most of a bank’s loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank once again holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.
The tricky part of monetary policy is making sure there is enough money in the economy, but not too much. When people have the money to demand more products than the economy can supply, prices go up and the resulting inflation hurts everyone. While in the United States we get concerned when inflation climbs above 3 percent a year, we’ve been more fortunate than some other countries. Just imagine trying to survive in post-World War II Hungary, for instance, where inflation for awhile averaged nearly 20,000 percent per month!

M1, which is the most basic measure of the money supply (defined as currency in circulation, plus demand deposits or checking account balances.) shows the effects of loaned money, as it is deposited in checking accounts. And remember the money multiplier effect, which can turn a mere $10,000 loan into $100,000 at a reserve requirement of 10%. (Sadly, one thing that shocked me when I discovered it a year or so ago, was that the reserve requirement had actually been slowly dropped to nearly nothing, a huge factor in our current woes as far as I’m concerned.)

A couple of articles you may be interested in: This one is informative and I generally agree with her, except on her conclusion. I don’t think monetizing the debt is desirable, it only forestalls the inevitable day of reckoning and you have to invoke inflation to do it. (Besides, the Fed is already doing what she recommends, buying our own treasuries.)

This one seems to have been written in 2004 or 2005. She makes some excellent observations and history has shown that there were consequences for the “nirvana” she witnessed. We have gone bust.

If you consider customer service to be a service sector job, we are also losing those as well. In fact, if a job isn’t nailed to the floor it will fly away, or so it seems. The only safe jobs, it seems are those that cannot be done successfully from abroad, like waiting tables or ringing up purchases.

I do seem to have touched a nerve with my “delicately balanced machine” analogy…

I can see where my analogy could break down, it wasn’t meant to be a scientific analysis, but rather a general picture of the way an economy works. My intention was to illustrate the fact that wages, prices, and productivity need to be kept in proportion to one another if things are to run smoothly. Two excellent examples would be the runaway prices of real estate in the past decade and the bust that followed, and the gaping disparity between incomes on the high end and low end for the past twenty years which are also historically followed by a bust.

I do thank you for the tip on John Nash and equilibrium/game theory. (It was a fun scavenger hunt for me to research it.) My conclusion is that human behavior cannot be neatly categorized or predicted with any level of certainty, which is exactly why economics is so much like predicting the weather; hit or miss. In this regard, Nash’s theory is nice, but can fail in practice. In any event, it is true that when you take the sum total of all economic transactions there are trends that can be parsed out and the ultimate outcome is that most people will make deals that are for their own perceived benefit. There may be more than one definite “strategy” that is the optimum level, but in essence, there are strategies that are best, and most people do use them. At least, this is true in general. I don’t think Nash took into account the mind numbing effects of advertising, though, which encourage people to make purchases that are on the outside quite foolish, but to the ad influenced consumer provide some perceived benefit such as status or hopefully improved sexuality. In any event, it does seem that there have been a lot of poor economic decisions made in the past twenty years, as the real estate bubble bursting has shown. Many people thought they were getting something wonderful by moving into very expensive homes (status!) that they couldn’t really afford, but reality hit them in the behind and they fell flat on their face when reset time came around. So clearly, it is quite possible for the ‘game players’ to use “strategies” that do not benefit them, and pay for it dearly. There are obviously society and spiritual (!) effects in play as well.

My economic theory (loosely put) is that economies run in cycles, which are predictable. (My interpretation of the pride cycle.) And as such, since people have a tendency to behave foolishly for x number of years before reality calls for a course correction and a clearing out of bad debt, it is wise for the prudent economic participant to save money against the inevitable “rainy day” and stay out of debt as much as is possible, in order to ride out the storm.

I guess the economy would be more like the silly contraption I saw in a Dr. Seuss book with oddly shaped wheels (kind of oval) that would at some point put the rider high in the air until it came crashing down on the flatter side, you enjoy the high point, but steel yourself for the inevitable drop.

About the Author

Connor Boyack is president of Libertas Institute, a public policy think tank in Utah. He is the author of several books along with hundreds of columns and articles championing individual liberty. Connor's work has been publicly praised by national figures such as Ron Paul, Judge Andrew Napolitano, Tom Woods, and many others.

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